ECON201PS4 - WELLESLEY COLLEGE DEPARTMENT OF ECONOMICS...

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WELLESLEY COLLEGE DEPARTMENT OF ECONOMICS ECONOMICS 201-03 JOHNSON Problem Set #4 (due by IN LECTURE Friday, October 3 rd ) 1. 2. Recent research has confirmed that, starting from equal levels of work effort in the 1980s, the average American now works roughly 20% more (in terms of hours worked) than the average citizen of Western Europe. Most of this gap has resulted from reductions in European work effort levels; U.S. average work effort levels have largely remained constant since the 1980s. Consider two competing hypotheses to explain this empirical observation: Edward Prescott, the 2004 Nobel Laureate in economics, claims: "Virtually all of the large differences between U.S. labor supply and those of Germany and France are due to differences in tax systems." Supporting his claim are the facts that Europeans face higher tax rates than do Americans and that European tax rates have risen substantially over the past twenty years or so. Olivier Blanchard, macroeconomist at MIT, instead proposes the following explanation: "…the main difference between the U.S. and Europe is that Europe has used some of the increase in productivity to increase leisure rather than income, while the U.S. has done the opposite." Draw diagrams (one for the average U.S. worker and one for the average European worker) that would support Prescott's thesis, namely that higher tax rates have driven down European work effort levels. Draw diagrams (one for the average U.S. worker and one for the average European worker) that would support Blanchard's thesis, namely that higher productivity (and thus higher wages) in both the U.S. and Europe over the past several decades have resulted in different responses of the average U.S. and European worker. In what way(s) do your results depend on the tastes for AOG vs. leisure in the U.S. and Europe? Explain.
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3. Your preferences are summarized by the utility function U ( N , Y ) = N*Y 3 where Y is a composite good and N is the number of leisure hours you consume each day. Thus, 24 – N = L where L is the number of labor hours each day. Also assume that you have some non-wage income
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ECON201PS4 - WELLESLEY COLLEGE DEPARTMENT OF ECONOMICS...

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